Reforming the tax system to make it simpler, broader and firmer should be the central pillar of fiscal reform. Tax reforms can play a forceful role in spurring growth, by removing distortions, enhancing transparency as well as predictability, increasing the efficiency of tax administration and boosting the tax to GDP ratio.
The thrust areas are: Introducing the Goods and Services Tax (GST), reorienting the Direct Taxes Code (DTC), increasing the efficiency of tax administration, putting in place transparent tax structures, incentives and holidays for the manufacturing, infrastructure and power sectors, fast-tracking settlements of tax disputes and streamlining the tax dispute redressal mechanism.
And, higher spending on social welfare, human resources development, physical infrastructure and science and technology innovation will certainly help drive inclusive and sustainable growth.
Unfortunately, India’s fiscal position does not leave any room for stimulus. Prior to the global financial crisis, the country had been on a steady course to reduce the large fiscal deficit, thanks to the strict Fiscal Responsibility and Budget Management (FRBM) Act.
By 2007-08, the deficit had narrowed to around 2.5 per cent of GDP, from 6.0 per cent earlier. While government spending was kept at prudent levels, tax buoyancy helped contain the fiscal deficit at modest levels. The introduction of Value Added Tax (VAT) in April 2005 and increased corporate tax receipts at a time of buoyant industrial growth. Moreover, personal income tax receipts also showed a significant upward movement in the last decade.
Urge to splurge On the other hand, some of the largest spending sprees undertaken by the Government, supported by healthy revenues, were more structural in nature.
These included hikes in public sector salaries, massive debt write-offs for small farmers, increasing subsidies for energy products and the expansion of the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGA).
However, since the onset of the global financial crisis in 2008-09, the stability of government finances eroded considerably. This was partly due to discretionary measures implemented to support the economy, including tax cuts as well as a cyclical weakening of tax revenues.
While fiscal deficit is expected to moderate to 4.6 per cent of GDP in 2013-14, it still remains above its pre-crisis level of 2.5 per cent and also higher than the level mandated by the FRBM Act.
Therefore, the Government has to strengthen the fiscal framework through legislative and institutional reforms, improve spending efficiency through its targeting and delivery mechanisms, push for implementation of GST while minimising exemptions to keep the base as broad as possible and aim for a single rate in every state, implement a revised DTC to streamline tax collection, reduce the overall burden of direct taxes and push reforms in the area of international taxation.
The Centre must implement a national GST, which, coupled with a state GST, will rationalise indirect taxes while preserving states’ financial autonomy. This will entail seamless taxation throughout the chain of production and distribution and include goods and services at both the Central and state levels.
A tax must To keep the overall rate low, the base should be made as broad as possible. A single tax rate should apply to each state; where differential rates apply, they should be kept low and limited to a small range of products. It’s a big ask, but the Government should not be unnerved.
A consensus on DTC needs to be arrived at as early as possible. The proposed changes will increase the tax-free threshold, releasing many low-income taxpayers from the net, thereby reducing administration costs. This will also reduce the corporate tax rate and broaden the corporate tax base. Additionally, the Government can bring some part of farm revenues into the net.
Another proposal is to reduce tax on savings, including making contributions to pension schemes tax-free. While this measure will help promote savings, it is vital that the Government adopts a balanced approach towards taxation and speeds up reforms already on track.
The Government also needs to ensure a certain level of stability in the area of international taxation. The specific reference here is in regard to retrospective amendments for taxability of indirect share transfers, taxability of software and services royalty.
Some of these amendments have had a negative impact on the investment and business climate. Efforts must also be made to re-negotiate certain tax treaties, clauses for limitation of benefit and tax information exchange arrangements.
Mop up the GAAR gore After the General Anti-Avoidance Rules spooked market sentiments and hurt foreign investments in 2012, the Government diluted the provisions and deferred its coming into force until April 2016.
However, to attract FDI, the Government must address issues concerning taxation of foreign companies in a manner that balances its needs for expansion of the revenue base with investor confidence.
The growing volume of overseas investment into India over the last few years has boosted employment and helped develop infrastructure, but it has also led to a growing number of tax disputes.
The Government must make it clear to investors that the Indian tax administration is not adversarial. Simultaneously it must develop an excellent dispute resolution mechanism. Customs duties on import and service trade barriers have been declining.
Yet, barriers in both goods and services sectors are still higher than in most BRICS nations. Continued trade-related policy reforms will be crucial for sustaining growth.
Further, the Government should treat infrastructure projects, particularly water, roads and power at par with SEZ projects, including the extension of exemptions and tax benefits. Investments in the power sector should be encouraged by extending the tax holiday by five years to help realise the vision of ‘24x7 electricity’ for all.
Widespread informality still constricts tax collection in India.
Transparency and efficiency in taxation policies that plug leakages and lower compliance costs will be imperative for a stable economic regime. This is non-negotiable for the country’s economic progress and inclusive national growth.
The writer is the president of Assocham and MD and CEO of YES Bank